What is an ICO (Initial Coin Offering) and How Does it Work?

So what is ICO (Initial Coin Offering)?

An initial coin offering is similar in concept to an initial public offering (IPO), both a process in which companies raise capital, while an ICO is an investment that gives the investor a cryptocoin, more commonly known as a coin or a token in return for investment, which is quite different to the issuance of securities as is the case in an IPO investment.

Before getting into the details, it’s worth providing some detail on blockchains, tokens and cryptocurrencies.

What is a Blockchain?

A blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record, not just financial transactions, but anything of value. It’s essentially a digital spreadsheet that is duplicated across a network of computers. The network is designed to update the spreadsheets on a regular basis. As the information is shared and regularly updated and not stored in a single location, it’s considered to be truly public and easily reconciled.

Why is it considered revolutionary? Imagine not needing a single database that must be passed across global geographies and companies for updating…

What are Tokens?

Tokens are coins that are offered during an ICO and would be considered an equivalent to shares purchased in an IPO and are also referred to as cryptocoins.

What are Cryptocurrencies?

Cryptocurrencies are a digital or virtual currency that uses cryptography for security. It is not issued by any central authority, such as a central bank, taking it out of the reach of governments who can interfere or manipulate. The transactions are anonymous in nature.

Tokens issued from an ICO will have a value, with the ICO allocating equivalent to equity to the token, which gives the investor ownership with voting rights and, in certain cases, qualifying for dividends.

While this will be the closest format of an ICO to IPOs, the vast majority of ICOs issue tokens that are an asset giving investors access to the features of a particular project rather than ownership of the company itself.

It’s ultimately the process of crowdfunding a new cryptocurrency project, involving a token sale, with the cryptocurrency project raising capital to fund operations, with investors receiving an allocation of the project’s tokens in return.

ICOs tend to be open from between a few weeks to a month, though some have been open for longer and fund raising for a particular ICO possibly taking place on multiple occasions, unlike an IPO which is a onetime event.

Some key characteristics of an ICO include:

Participation in a project, Decentralized Autonomous Organization (DAO) or an economy.

Coin ICOs generally sell participation in an economy, while token ICOs sell a right of ownership or royalties to a project or DAO.

Owning tokens do not always give the investor a right to vote on the direction of a project or DAO, with the rights of the investor embedded within the structure of the ICO, though generally the investor will have input throughout a project lifespan.

The majority of ICOs involve the creation of a defined number of coins or tokens prior to sale.

ICO prices are usually established by the creators of the economy, project or DAO.

ICOs may have multiple rounds of fund raising, with coins or tokens on offer, increasing in value until the release date, with early investors likely to have greater rewards embedded within their tokens as an incentive.

ICOs conclude once the coins or tokens are tradable in the open market.

If we were to compare the key features of ICOs and IPOs, some of the similarities and differences would be as follows:

An IPO gives you ownership of the company based on the number of shares acquired, whilst an ICO may only give you rights of a particular project, not the company launching the project.

Decision making in IPO companies are centralized with the CEO and the board involved in the day to day running of the business, whilst with ICO companies/projects, decision making is decentralized, giving the investor a material decision making position.

Financial data is released as per the rules of the exchange on which the IPO took place, whilst for ICOs, these will either be public by way of the blockchain or as outlined within the white paper and agreement with the investors.

Companies launched by way of an IPO must pay taxes, with investors having to pay capital gains tax, whilst for ICOs, the company may not be subject to direct tax, only the investor being required to pay capital gains tax.

An IPO is a onetime sale with multiple intermediaries involved in the process of determining the conditions, pricing, etc., whilst ICOs can have multiple rounds of fund raising, with few if any intermediaries, the white paper the blueprint.

And finally, stock exchanges and companies listed by IPO are heavily regulated, whilst the exchanges on which ICOs are launched are quite the opposite.

For companies raising capital through ICOs, the advantages include:

The project, DAO or economy is not necessarily subject to direct taxation, which in contrast to companies fund raising through IPOs.

Sales of coins or tokens are direct, including multiple rounds, with few if any intermediaries required in the process, investors basing investment decisions on the content of white papers prepared by the fund raising entity.

While ICOs are to mainly raise capital for a start up, they are also used to kick-start the sale of a service to be taken to market or the use of a new cryptocurrency.

On most occasions, the investor becomes the consumer of the service being offered by the company raising funds through an ICO, which allows investors to buy coins at a discount, though valuation will ultimately be dictated by supply and demand once released to market.

How Does ICO Work and How to use ICO

Start ups kick start the ICO process by establishing the blockchain and set up of protocols and rules, at which point an ICO data is announced.

For the creator, the next step is to begin mining for coins that will sold during the ICO, with social media sites, Reddit and a rising number of cryptocurrency related website used as a marketing medium to attract investors ahead of the ICO data, creators looking to draw in as much interest as possible to not only raise the required funding, but also push demand and prices post ICO.

In the background, the creators will make their final checks and adjustments to ensure its smooth sailing by the time of the ICO.

For the cryptocurrency creators, they will need to join an exchange, the exchange similar to that of a stock exchange during an IPO, with investors needing to have an account with the exchange to be able to buy the new cryptocurrency with other cryptocurrencies or fiat money.

Active and up and coming ICOs can be found through various sites, with the purchase of cryptocurrencies being made through the selected exchange, with investors also able to buy directly through the creators official website.

Exchanges that are widely recommended for the purchase of new coins include Bittrex, Kraken, Poloniex, Livecoin, SpaceBTC, Bitlish, though there are many others.

Documentation requirements vary depending upon the investor domicile, with the requirements outlined on the respective exchange’s site and creator website.

A step by step of an ICO can be summarized as follows:

Pre-Announcement: This is the marketing stage of a future project through sites frequented by cryptocurrency investors, with the creators of the project preparing a white paper, essentially an investor presentation outlining the details of the project.

Once the white paper has been circulated, the company will get a sense of whether there is investor interest in the project proposed, with the company then addressing concerns and addressing risks raised by would be investors to reach a final business model and a final version of the white paper.

Offering: This is the final version of the white paper, setting out the terms of a contract for the benefit of the investors, made on behalf of the company entering into the ICO.

The offer will outline the project details, the total amount of capital required, together with project timelines. It will also indicate the financial instrument to be sold during the ICO, normally tokens. The financial instrument will have a value assigned to it, together with the rights of the investor along with the expected period after which the company will commence returning earnings to investors, traditionally by way of dividends.

Once the offer has been signed, the ICO start date is announced and the marketing campaign moves into overdrive.

Marketing Campaign: This is a pivotal component of the ICO, with the marketing campaign key to the company being able to raise the necessary capital. Companies are generally nascent and unknown, bringing marketing agencies into the frame to make the necessary presentations, etc. The campaign will tend to last up to a month on average, target audience being institutional and some smaller investors. Participants of crowdfunding programs tend to be the main segment, investors generally more willing to back projects, with their involvement in the project considered a positive for both the investor and the company.

Once the marketing campaign comes to an end, the buying and selling of tokens commences, with the company having established an exchange for investors to acquire tokens.

The ICO: Companies generally release tokens on blockchain in two ways:

Collect the specific capital, outlined within the offer, and then divide and distribute the tokens to the investors based on initial investment made.
Alternatively, tokens are sold on cryptocurrency exchanges, which means that the tokens need to be released on a number of exchanges in advance for trading.
Once the sale has ended, the company commences on its obligations.

For the investor, it’s a case of exploring the various exchanges or social media sites that publish active and up and coming ICOs and then opening an account, acquiring the tokens, having completed the necessary due diligence on the company or project in question.